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SPI Management Newsletter 28.07.23

US Economic Growth Accelerates as the Fed Raises Rates to 22-year High

Against expectations of a slowdown, the US economy experienced an uptick last quarter as the Federal Reserve boosted interest rates to a 22- year high. Despite the tightening of monetary policy, the economy stayed resilient, with Gross Domestic Product (GDP) increasing at an adjusted annual rate of 2.4% in the second quarter, up from 2% in the previous quarter.

The surge in economic growth has been attributed to a strong labor market and easing inflation, despite higher interest rates. The rate hikes, part of the Fed's strategy to curb inflation, had led some economists to predict a mid-year recession. However, these forecasts have since been revised, given the recent economic data.

The rise in GDP was primarily driven by robust business investments in buildings and equipment, and a resurgence of consumer spending, albeit at a slower pace. Nevertheless, rising interest rates are projected to weigh on future consumer spending as products that often require loans, such as vehicles and appliances, become more costly. While some experts predict a slowdown in consumer spending, business investment spiked by 7.7% in Q2, a significant jump from 0.6% in the first quarter. Federal spending on chip- manufacturing plants and electric-vehicle factories is believed to be aiding this investment boost.

On the other hand, the Federal Reserve raised its benchmark federal-funds rate to a range between 5.25% and 5.5%, marking the highest level in 22 years. This move, the 11th rate increase since March 2022, is part of the Fed's ongoing effort to manage inflation, which has eased from last year's 40-year high. However, Fed Chair Jerome Powell has not ruled out future rate hikes, emphasizing the need to monitor economic data and the time it takes for monetary policy to impact inflation. While the future of rate increases remains uncertain, the Fed's focus is now shifting towards achieving its 2% inflation target without causing a recession. This outlook is supported by improving consumer confidence, optimism in small businesses, and a strong labor market. Furthermore, the International Monetary Fund recently suggested that global and US economic growth this year might exceed previous estimates due to these factors.

ECB Takes a Balanced Approach Amid High Inflation and Recession Fears, raises rates again

The European Central Bank (ECB) has raised its key interest rate by 0.25%, marking the ninth consecutive increase, and taking the deposit rate to a 22-year high of 3.75%. The move aims to curb high inflation, which has proven to be a more stubborn foe than expected. However, it also stokes fears of a potential recession. ECB President Christine Lagarde stated that the bank has an open mind about future decisions, and they could include further hikes or a pause, depending on incoming economic data.

Despite aggressive rate hikes by major central banks over the past year, inflation persists and remains too high, especially in Europe. While some central banks such as those in Australia, Canada, and the U.S. have paused their rate increases for several weeks or months, they have also resumed raising rates.

Inflation across the eurozone has been declining but remains high at 5.5%, significantly above the ECB's target of 2%. Despite this, investors expect the ECB to continue raising rates towards 4% later this year before starting to cut rates again next year. The eurozone economy has been flirting with recession since the end of last year, and this, coupled with the ECB's rate increases, could put pressure on business and household spending. Nevertheless, ECB officials signaled that borrowing costs are likely to stay high for some time.

The International Monetary Fund (IMF) also chimed in, urging the ECB to contemplate pushing rates above 3.75% to prevent high inflation from becoming entrenched. This reflects the efforts of eurozone workers to regain their purchasing power by seeking higher wages, leading businesses to elevate prices to offset increased labor costs.

Adapted from WSJ, FT, NYT, Reuters, CNBC

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